Small Change

ust as April showers bring May flowers, there's a certain predictability to the federal financial audits released every spring. Most agencies' annual financial statements now pass muster with independent auditors-18 of 24 agencies required by law to undergo audits received unqualified, or clean, opinions on their 2001 financial statements. That's the same number that earned clean opinions last year. But few agencies produce timely, accurate financial data that enable their executives and program managers to make informed business decisions.

After agency financial statement results were reported in February, Office of Management and Budget Controller Mark Everson noted that improvements in financial management were real, but modest. "It's no great victory to be here on Feb. 28 marking the completion of audits that relate to the fiscal year that ended five months earlier-that's an unacceptable delay in preparation of financial information," Everson says. Nonetheless, just four years ago only 10 agencies got clean audits when the General Accounting Office reviewed agency books several months after the close of fiscal 1997.

How well-or how poorly-agencies manage their finances has a significant effect on how well they can perform their missions. And the federal government is involved in virtually every aspect of American life-it enforces laws; sets standards for public health and safety; ensures safe food, clean air and water; and defends the lives and property of Americans from human and natural disasters, to name just a few things for which federal agencies are responsible. To maintain public support and make the most of limited tax dollars, agencies must improve their stewardship of the resources they manage. As agencies refocus and reprioritize their efforts to fight terrorism, financial management is becoming even more important. Not only will improved financial management save money that could be better spent on critical operations, but the same controls and security measures that ensure the integrity of financial data often are vital to protecting other critical elements of the infrastructure and other data.

For more than a decade now, members of Congress and officials at OMB and GAO have been nudging, encouraging and threatening agencies to put their financial houses in order. The campaign began with the 1990 Chief Financial Officers Act, which required the 24 agencies responsible for virtually all federal spending to reorganize their finance staffs and prepare audited annual statements. The results are beginning to show. The six agencies reviewed in this year's Federal Performance Report either received clean opinions on audits of their financial statements, or belong to larger departments that received clean opinions, meaning their financial statements were deemed to be accurate. That's not to say they don't have serious problems managing their money.

The Social Security Administration, the Centers for Medicare and Medicaid Services and the IRS frequently make erroneous payments. As a result, they lose billions of taxpayer dollars every year. The Immigration and Naturalization Service doesn't have adequate record-keeping systems, making it impossible to track application fees and other data properly. The Federal Aviation Administration cannot accurately account for all of its property on a continual basis, and, along with the Environmental Protection Agency, lacks adequate security controls on critical data systems, leaving agency financial systems vulnerable to fraud and abuse.

While cleaning up financial data continues to be enormously challenging for agencies-six, including the Defense Department, which accounts for half of all discretionary spending, are still unable to do it-that's only the beginning of true accountability. Tying financial data to actual operations is the real hurdle, one most agencies are just now beginning to confront, says Everson. "When you talk about the standards for success, which is the overall vision for what we want to do, the toughest point is clearly this integration of operating systems and financial systems so that you have information that you can use on a day-to-day basis to make decisions," says Everson.

Even for most of those agencies able to get clean audit opinions, true financial management and accountability remain elusive goals. Nearly every federal agency is in the process of installing new finance and accounting computer systems that will automatically capture and generate the kind of data required under a host of new financial management and reporting laws enacted since the CFO Act was passed. In the meantime, agency finance personnel, usually with contractor support, often go through excruciating manual data reconciliation exercises at the close of every fiscal year to produce their financial statements. Michelle Snyder, chief financial officer at the Centers for Medicare and Medicaid Services, says CMS struggles to close out its books every year. "We have to do a lot of ad hoc spreadsheets where you spend a lot of time and person power doing manual reconciliation," Snyder says.

The INS has a similar problem. Operations at several facilities were halted for more than a week last fall while employees and contractors counted nearly 2 million benefits applications as part of a comprehensive inventory of pending applications. Glenn Fine, inspector general at the Justice Department, the INS' parent agency, says, "The INS will need to continue performing these year-end manual counts until it can successfully implement an automated system that accurately tracks financial information on a regular basis, rather than rely on Herculean efforts at the end of the fiscal year to produce unqualified opinions."

While INS officials were counting benefit applications by hand, FAA officials at headquarters were creating their own ad hoc process to accurately account for property that would circumvent the agency's unreliable asset-tracking system. Kenneth Mead, the Transportation Department's inspector general, credited FAA with making substantial progress in financial management, but he cited property management as an ongoing weakness.

NASA, one of the agencies reviewed in the 2001 Federal Performance Report, knows how difficult such manual efforts can be. The agency earned clean audit opinions for seven years, but only through extraordinary efforts by finance personnel and contractors, who manually reconciled data that NASA's disparate legacy systems never were designed to capture and process. Last year, Stephen Varholy, chief of NASA's financial management division, told Government Executive that without the new financial management system NASA has been trying to implement for several years, the agency might not be able to sustain its clean opinions. "To be very honest, if we don't get the new system in place, our luck's going to run out on us," Varholy said.

NASA's luck ran out this year. Not only did the agency lose its clean opinion, it received a disclaimer, meaning its books were deemed to be in such disarray they could not be audited. Everson says NASA's downgraded status reflects a number of things. For the first time, International Space Station operations were included in NASA's audit, raising a number of new concerns for auditors. They also questioned how the property of contractors was capitalized and accounted for. That's an issue because of the agency's heavy reliance on contractors.

NASA's bookkeeping likely received greater scrutiny this year from auditors at PricewaterhouseCoopers after GAO reported significant problems with accounting firm Arthur Andersen LLP's audit of NASA's 1999 financial statement last year. (Agency financial audits are conducted by agency inspectors general or by independent accounting firms that the IGs hire.) The GAO report was prompted when House Science Committee staff members noticed discrepancies between the president's fiscal 2001 budget and NASA's 1999 financial statements. When GAO looked into the discrepancies, it found that Arthur Andersen's audit of NASA's 1999 financial statement failed to recognize a $644 million reporting error. The error apparently occurred as a result of NASA's ad hoc process for capturing financial data, a process Andersen auditors apparently knew nothing about.

"The systems deficiencies that led to the error and Arthur Andersen's lack of understanding of the ad hoc process used by NASA to work around these deficiencies also raise questions about Arthur Andersen's conclusion that NASA's financial management systems comply substantially with [statutory requirements]," GAO found in a March 2001 report (GAO-01-438). Although Arthur Andersen disputed GAO's findings, the report concluded that working papers provided by the accounting firm relating to the firm's audits for 1996 through 1998 did not support the unqualified audit opinion the agency received in 1999.

At a March 2002 hearing of the House Government Reform Subcommittee on Government Efficiency, Financial Management and Intergovernmental Relations, NASA Administrator Sean O'Keefe agreed that the agency's financial management problems were long-standing and serious, despite clean audits in previous years, and said the agency is committed to resolving them.

Linking Costs to Operations

While integrated cost-accounting systems still are largely under development, some agencies have been using one form of cost accounting, activity-based costing, to glean more accurate information about discrete operations. The INS, for example, has used activity-based costing to isolate the direct costs of providing some services to justify fees for its benefit programs.

At the IRS, officials still are working out how their cost-accounting system will be structured to capture relevant data across the agency. "Our biggest challenge is making sure the cost-accounting component of [IRS' financial system] provides us with a level of granularity that allows us to really measure what is going on out in the organization," Grams says. "If cost accounting is any good, it's got to be driven by the questions of how are you spending your money and what are you getting for your money. We're going through the process right now with operational units to discuss with them what level of detail they need and how they need it."

Developing meaningful performance measures and tying them to financial data is a huge challenge, CMS' Snyder says: "If you're looking at health outcomes for seniors, what are the things you should be measuring and how should you measure them? It's very different from building a bomber [where you need to know], 'Is it on time? Is it on budget?'''

Tying financial data to performance is a challenge for virtually every agency. To better integrate the INS' budget and performance goals, the Bush administration wants to substantially realign the agency's account structure. The INS now has three main accounts: salaries and expenses, construction, and immigration support. The accounts support 14 programs, which include categories such as the Border Patrol, adjudications and naturalization, and information and records management. Because of the way the budget is structured, the INS has no way to determine how much money it spends providing services, as opposed to enforcing immigration laws.

The new structure would have three accounts: enforcement, services, and support and administration. Six programs would be aligned with those accounts. Border enforcement, interior enforcement, detention and removals would be funded through the enforcement account. Immigration services would be funded through the services account. Information resource management and infrastructure and administrative support would be funded through the support and administration account. The programs are linked to specific performance objectives in the INS strategic plan. By 2004, administration officials expect that the INS will be able to spread administrative and support costs across the other programs, eliminating the need for that account.

While the administration is aggressively pursuing financial reform at the INS, those plans might be overtaken by larger restructuring plans being discussed in Congress and within the administration. Because of concerns over fragmented responsibility for border security, lawmakers are considering integrating the Customs Service, part of the Treasury Department, with the INS. Resolution is likely months away, but the uncertainty complicates the lives of INS managers trying to move ahead with reforms.

Other agencies are seeking or implementing major financial management restructuring as well. The FAA, CMS and IRS are all in the midst of multi-year plans to integrate new financial management systems within their agencies, as well as across their parent departments, Transportation, Health and Human Services and Treasury, respectively. These multimillion-dollar projects are enormously complicated. The new systems are intended to link operational data with financial systems and will require new business processes as well as new relationships between program managers and financial managers.

Ongoing Problems

All agencies are vulnerable to fraud to some extent, but those that pay out large amounts of money in federal benefits and grants are especially at risk. SSA, CMS and the IRS all are working to combat erroneous and fraudulent payments. Last April, SSA Inspector General James Huse told the members of the Senate Finance Committee that his office estimated that SSA annually makes erroneous payments of nearly $50 million to prisoners. At CMS, where Medicare fraud is an ongoing concern, Inspector General Janet Rehnquist reported in February that CMS made $12 billion in improper Medicare payments last year, 6.3 percent of the $192 billion that Medicare paid overall. And that's the good news. In 1996, the agency's error rate was estimated at nearly 14 percent. Agencies clearly have a long way to go to eradicate improper payments and fraud, but their audits suggest they're having some success at reducing them.

The cultural changes needed to improve financial management are as great or greater than the technical requirements, says Everson. Until performance data, strategic plans and budget plans are effectively linked, agency managers will spend more time producing reports than managing programs effectively. "You've got financial statements floating out there, you've got budgets floating out there, performance reports-they aren't tied together," says Everson. OMB intends to change that. This year, for the first time, agencies will be required to produce integrated accountability and performance reports.

Everson concedes that agencies are under enormous pressure. In addition to requiring integrated reports, OMB has stepped up other requirements. This year, agencies will produce six-month financial statements before moving to quarterly financial statements next year. Also, the year-end reporting deadline will move from March 1 this year to Feb. 1 for 2002 financial reports. By the time 2004 statements are due, the deadline will be just a month and a half after the close of the fiscal year.

"We recognize that this is a very aggressive change that will require the agencies and departments to totally redesign a lot of their business processes and make changes in some of their systems, not to mention working in a different way with their auditors and IGs," Everson says. "We're making progress, but there's a long way to go."

• Does the agency have accurate and consistent information on the availability and use of its financial resources, and does it track the allocation and sources of funding?

• Does the agency maintain accurate and complete records of uses of funding that can be tracked to programs and activities?

• Within the constraints imposed by Congress through the budget, is the agency flexible in its application of resources to functions and programs that can best help accomplish the mission?

• Does the agency project future sources and uses of funding and create contingency plans for possible reductions and increases?